Thursday, May 9, 2013

Tip of the Hat

Picking up on an earlier Keynes' theme, I stumbled upon this piece courtesy of David Frum. It is well written, well laid out, thoughtful, insightful and, given the current state we're in, economically speaking, highly relevant. There's nothing like a former drinker of the Kool-Aid to dispense with false doctrines.

What's amazing about the piece is how closely it aligns itself with what Paul Krugman has been saying for years. Hmmm.

Over the weekend, there was a kerfuffle about whether Keynesian economics ignores the long-run implications of its policies. The Harvard historian Niall Ferguson asserted that this was the case and said that it resulted from the British economist John Maynard Keynes’s homosexuality. Professor Ferguson said that those without children, as is the case with most gay men and women, necessarily had less of a long-term view of the world than those with children who will live on after their death.

Professor Ferguson has apologized for his off-the-cuff comment, which was widely interpreted as being homophobic. But before this incident fades from memory, I’d like to take the opportunity to discuss the questions raised by it: Is Keynes’s sexual orientation at all relevant to the interpretation of his economic theories? Does Keynesian economics completely ignore the long run?

First of all, Keynes’s sexual orientation has been known for some time, at least since publication of Michael Holroyd’s biography of Lytton Strachey in 1968. Strachey was a noted biographer, an active member of the literary Bloomsbury Group and one of Keynes’s lovers.

The revelation of Keynes’s homosexuality greatly excited his right-wing enemies, who have long used it to defame him and discredit his theories. A 1969 book, “Keynes at Harvard: Economic Deception as a Political Credo,” contains a long chapter on the subject, which describes Keynes as “a lifelong sexual deviant.” Like Professor Ferguson argued, it says that Keynes’s “aversion to human conception” was a key to his economic theories, which the book likened to Bolshevism.
The author of “Keynes at Harvard” is Zygmund Dobbs, but the driving force behind it was Archibald B. Roosevelt, who founded the Veritas Foundation, which published the Dobbs book. The youngest son of Theodore Roosevelt, Archibald Roosevelt was very active in right-wing politics throughout his life, attacking both Presidents Franklin D. Roosevelt and Harry S. Truman for coddling communists. In 1954, Archibald Roosevelt demanded that an organization named for his father rescind an award to the United Nations under secretary Ralph Bunche because of his “close affiliation with communism.”

Brad DeLong, an economist at the University of California, Berkeley, has posted a long list of conservative attacks on Keynes that have used his homosexuality as a reason to reject his economic theories. But even economists who had no interest in this aspect of Keynes’s life, like the economist James Buchanan, have criticized Keynesian economics for its excessively short-term focus and negative long-run consequences.

Unfortunately, Keynes himself was to a large extent responsible for giving this criticism of his work currency. That is because he titled his most important work “The General Theory of Employment, Interest and Money.” The term “general theory” obviously implies that it is applicable at all times, in all economic situations.

This was an unfortunate error, because the core insight of Keynesian economics is that there are very special economic circumstances in which the general rules of economics don’t apply and are, in fact, counterproductive.

This happens when interest rates and inflation are so low that there is no essential difference between money and bonds; money, after all, is simply a bond that pays no interest. When this happens, monetary policy becomes impotent; an increase in the money supply has no stimulative effect because it does not lead to additional spending by consumers or businesses.

Keynes called this situation a “liquidity trap.” Under such circumstances, government spending can be highly stimulative because it causes money that is sitting idle in bank reserves or savings accounts to circulate and become mobilized through consumption or investment. Thus monetary policy becomes effective once again.

This is an extremely important insight that policy makers have yet to grasp, even though interest rates on Treasury bills are just a couple of basis points above zero and inflation is virtually nonexistent. Although the Federal Reserve has increased the monetary base to almost $3 trillion today from $825 billion in 2007, it has had little apparent stimulative effect.

In normal times, one would expect such an increase in the money supply to be highly inflationary and sharply raise market interest rates. That this has not happened is proof that we have been in a liquidity trap for several years. We needed a lot more government spending than we got to get the economy out of its doldrums.

Although Keynes’s theory was most appropriate to the Great Depression, his followers did indeed believe in its general applicability and the Keynesian medicine was overapplied and misapplied during much of the postwar era, leading to stagflation in the 1970s. Conservatives like Professor Buchanan were right about that.

But in their rejection of Keynesian economics at a time when it needed to be rejected, conservatives threw the baby out with the bathwater and are now preventing its adoption when it is badly needed.

The criticism that Professor Ferguson implicitly leveled at Keynes of being excessively short-term oriented, therefore, has a grain of truth in it. But the much greater truth is that we are now holding the economy hostage to policies that are proper for the long-term – like stabilizing the debt-to-gross-domestic-product ratio – at a time when we face special circumstances that make such policies perverse.

In short, we are suffering from an excessive long-term focus that is crippling the economy in the short run, and the short run threatens never to end.

A friendly 1984 biography of Keynes by the economist Charles H. Hession acknowledged that his sexual orientation shaped his political philosophy. His homosexuality was “an independent element in his reformist tendency; as such, he was an outsider in a heterosexual world,” Professor Hession wrote.

I think this made Keynes more willing to think “outside the box,” as we say today, and consider ideas that ran counter to the conventional wisdom. But there is no reason to think he had any less concern for the long-run health of the economy or society than heterosexuals. Keynes understood that the long run is simply an infinite parade of short runs.

But Keynes erred in implying a more general applicability of his theories than he should have. We suffered for this in the past when they were misapplied in inappropriate circumstances, unfortunately discrediting them and preventing their adoption now, in highly appropriate circumstances.